By Bill Thomas, head of US equity investment team, BAring Asset Management, Boston The recovery ...
By Bill Thomas, head of US equity investment team, BAring Asset Management, Boston
The recovery in stock prices over the summer has brought welcome relief from the declines of the past three years. We believe the recovery is sustainable, as most of the headwinds facing investors at the beginning of this year have subsided.
Earnings are recovering in most sectors, and should be further supported by improving economic growth in the quarters ahead.
We continue to caution, however, that earnings and economic growth, while improving, are likely to remain restrained by past standards. Factors include the low level of nominal growth due to low inflation, generally high debt levels, overcapacity in many sectors and the lack of upside leverage in housing and car markets, which have remained strong over the past three years.
Still, recent economic data has been encouraging in the US, with machinery orders, industrial production and retail sales all surprising on the upside.
The forward looking indicators such as the ISM manufacturing survey broke the critical 50 level at 51.8, while the ISM service sector survey set a new high at 65.1.
It remains to be seen what effect the recent blackout in the Northeast and Midwest will have on economic activity. One estimate suggests as much as 0.5% off the pace of growth. However, the overall trend remains positive.
Corporate profits have been better than expected too, with tight cost control from management helping in the way of compensation for generally modest sales growth in most industries. Most corporate executives remain cautious in their outlook statements, leaving some scope for further positive surprises later in the year as the pace of economic growth picks up.
Steady dividend growth continues to be a supportive feature of the market, with the yield on the S&P 500 Index only about 1.5% below the yield on the FTSE All-Share in the UK.
For the first half of the year, the strongest outperformance of the index occurred in stocks and sectors that had been some of the worst performers last year, in the face of still difficult fundamental conditions. Such market action is not unusual at turning points, this time reflecting a decline in risk aversion and the anticipation of recovery.
However, with the S&P 500 Index now approximately 25% above the 11 March low, fairly valued against bonds and trading at a multiple of 19 times estimated 2003 earnings, it will be important to remain selective in choosing stocks for continued outperformance.
We believe investors will return to the quality companies and market leaders in all sectors for the next stage of the market's recovery, as these companies are more likely to produce strong earnings growth in the coming quarters.
Our portfolios are positioned for continued recovery in the economy and in corporate profits. A combination of established and developing leaders will be rewarding to portfolio performance in the continued challenging investment environment that almost certainly lies ahead.
Economic growth in the US looks sustainable.
Corporate profits have exceeded expectations.
Investors returning to quality companies.
Power blackout may affect.
Equity market fairly valued against bonds.
Moderate but volatile market still likely.
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